Discipline of Business Analytics

Equity portfolio diversification with high frequency data

Dr Vitali Alexeev, University of Tasmania

1st Nov 2013 11:00 am - Room 498 Merewether Building H04

Investors wishing to achieve a particular level of diversification may be misled on how many
stocks to hold in a portfolio by assessing the portfolio risk at different data frequencies. High
frequency intradaily data provide better estimates of volatility, which translate to more
accurate assessment of portfolio risk. Using 5-minute, daily and weekly data on S&P500
constituents for the period from 2003 to 2011 we find that for an average investor wishing to
diversify away 85% (90%) of the risk, equally weighted portfolios of 7 (10) stocks will suffice,
irrespective of the data frequency used or the time period considered. However, to assure
investors of a desired level of diversification 90% of the time, instead of on average, using low
frequency data results in an exaggerated number of stocks in a portfolio when compared with
the recommendation based on 5-minute data. This difference is magnified during periods
when financial markets are in distress, as much as doubling during the 2007-2009 financial
crisis.
Keywords: Portfolio diversification, high frequency, realized variance, realized correlation.